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Chapter 16 Depreciation Methods

Solutions to Problems 16.1 16.2 Other terms are: recovery rate, realizable value or market value; depreciable life; and personal property Book depreciation is used on internal financial records to reflect current capital investment in the asset. Tax depreciation is used to determine the annual tax-deductible amount. They are not necessarily the same amount. MACRS has set n values for depreciation by property class. These are commonly different usually shorter than the actual, anticipated useful life of an asset. Asset depreciation is a deductible amount in computing income taxes for a corporation, so the taxes will be reduced. Thus PW or AW may become positive when the taxes due are lower. (a) Quoting Publication 946, 2003 version: Depreciation is an annual income tax deduction that allows you to recover the cost and other basis of certain property over the time you use the property. It is an allowance for the wear and tear, deterioration, or obsolescence of the property. (b) An estimated value of property at the end of its useful life. Not used under MACRS. (c) General Depreciation System (GDS) and Alternative Depreciation System (ADS). The recovery period and method of depreciation are the primary differences. (d) The following cannot be MACRS depreciated: intangible property; films and video tapes and recordings; certain property acquired in a nontaxable transfer; and property placed into service before 1987. 16.6 (a) Quoting the glossary under the taxes-businesses section of the website: A decrease in the value of an asset through age, use, and deterioration. In accounting terminology, depreciation is a deduction or expense claimed for this decrease in value.

16.3 16.4

16.5

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(b) A yearly deduction or depreciation on the cost of certain assets. You can claim CCA for tax purposes on the assets of a business such as buildings or equipment, as well as on additions or improvements, if these assets are expected to last for some years. It is the equivalent of tax depreciation in the USA. (c) Real property includes: a mobile home or floating home and any leasehold or proprietary interest therein. in Quebec, immovable property and every lease thereof; and in any other place in Canada, all land, buildings of a permanent nature, and any interest in real property. 16.7 (a) B = $350,000 + 40,000 = $390,000 n = 7 years S = 0.1(350,000) = $35,000 (b) Remaining life = 4 years Market value = $45,000 Book Value = $390,000(1 0.65) = $136,500 16.8 Year 0 1 2 3 4 5 Book Value $100,000 90,000 81,000 72,900 65,610 59,049 Part (a) Annual Depreciation 0 $10,000 9000 8100 7290 6561 Part (b) Depreciation Rate____ ----10 % 9 8.1 7.3 6.56

(c) Book value = $59,049 and market value = $24,000. (d) Plot year versus book value in dollars for the table above

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16.9 Write the cell equations to determine depreciation of $10,000 per year for book purpose and $5000 per year for tax purposes and use Excel x-y scatter graph to plot the book values.

=$C$3/$A$8 =$E$3/$A$13

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16.10 (a) By hand:

B = $400,000

S = 0.1(300,000) = $30,000

Dt = (400,000-30,000)/8 = $46,250 per year t ( t = 1,,8) BV4 = 400,000 4(46,250) = $215,000 (b) Using Excel: Set up cell equations for depreciation and book value to obtain the same answers as in (a). Spreadsheet shown below. (c) Change the cell values to B= $350,000 (C3) and n = 5 (C6). Use the same relations. S = $35,000 Dt = $83,000 BV4 = $118,000

One spreadsheet is used here to indicate answers to both parts.

16.11 (a) Dt = 12,000 2000 = $1250 8 (b) BV3 = 12,000 3(1250) = $8250 (c) d =1/n = 1/8 = 0.125 16.12 BV5 = 200,000 5 * SLN(200000,10000,7) Answer is $64,285.71 16.13 Use the spreadsheet below. (a) BV4 = $450,000
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(b) (c)

Loss = BV4 - selling price = 450,000 75,000 = $375,000 Two more years when book value is $300,000

16.14 (a)

B = $50,000, n = 4, S = 0, d = 0.25 Yeart 0 $50,000 1 2 3 4 Dt --------$12,500 12,500 12,500 12,500 Accumulated Dt --------$12,500 25,000 37,500 50,000 Accumulated Dt ------$8,500 17,000 25,500 34,000 BVt 37,500 25,000 12,500 0

(b)

S = $16,000, d = 0.25, B - S = $34,000 Year 0 1 2 3 4 Dt ------$8,500 8,500 8,500 8,500 BVt $50,000 41,500 33,000 24,500 16,000

Plot year versus Dt, accumulated Dt and BVt on one graph for each salvage value. (c) Spreadsheets for S = 0 and S = $16,000 provide the same answers as above. 16.15 Use a difference relation (US minus EU) for depreciation and BV in year 5 with the SLN function.
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16.16 d is amount of BV removed each year. dmax is maximum legal rate of depreciation for each year; 2/n for DDB. dt is actual depreciation rate charged using a particular depreciation model; for DB model it is d(1-d)t-1. 16.17 (a) B = $50,000, n = 3, d = 2/n = 2/3 = 0.6667 for DDB Annual depreciation = 0.6667(BV of previous year) Year 0 1 2 3 16.17 (cont) (b) Use the function DDB(50000,0,3,t,2) for annual DDB depreciation in column B. The plot is developed using Excels xy scatter chart function
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Depreciation, Accumulated Eq. [16.5] depreciation $33,335 $33,335 11,112 44,447 3,704 48,151

Book value $50,000 16,667 5,555 1,851

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=DDB(50000,0,3,3,2)

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16.18 Set up spreadsheet; use SL and DDB functions; then plot the annual depreciation.

16.19 B = $800,000; n = 30; S = 0 (a) Straight line depreciation: Dt = 800,000 = $26,667 30 (b) t = 5, 10, 25, and all other years

Double declining balance method: d = 2/n = 2/30 = 0.06667 D5 = 0.06667(800,000)(10.06667)5-1 = $40,472 D10 = 0.06667(800,000)(10.06667)10-1 = $28,664 D25 = 0.06667(800,000)(10.06667)251 = $10,183 The annual depreciation values are significantly different for SL and DDB.

(c) D30 = 800,000(10.06667)30 = $100,959 16.20 SL: dt = 0.20 of B = $25,000


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BVt = 25,000 - t(5,000) Fixed rate: DB with d = 0.25 BVt = 25,000(0.75)t DDB: d = 2/5 = 0.40 BVt = 25,000(0.60)t Year, t d 0 1 2 3 4 5 SL 0.20 $25,000 20,000 15,000 10,000 5,000 0 Declining balance methods 125% SL 200% SL 0.25 0.40_ $25,000 $25,000 18,750 15,000 14,062 9,000 10,547 5,400 7,910 3,240 5,933 1,944

16.21 (a) For DDB, use d = 2/18 = 0.11111 D2 = 0.11111(182,000)(1 0.11111)21 = $17,975 D18 = 0.11111(182,000)(1 0.11111)181 = $2730 Compare BV17 with S = $50,000. By Eq. [16.8] BV17 = 182,000(1 0.11111)17 = $24,575 It is not okay to use D18 = $2730 because the BV has already reached the estimated S of $50,000. For DB, calculate d via Eq. [16.11]. d = 1 (50,000/182,000)1/18 = 0.06926 D2 = 0.06926(182,000)(0.93074)1 = $11,732 D18 = 0.06926(182,000)(1 0.06926)181 = $3721

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(b) For DDB: same values are obtained, with D18 = $0 in cell B22 here. For DB: DB function uses an implied 3-decimal value of d = 0.069, so the depreciation amounts are slightly different than above: D2 = $11,691 (cell D6) and D18 = $3724 by Excel.

16.22 The implied d is 0.06926. The factor for the DDB function is factor = implied DB rate / SL rate = 0.06926 / (1/18) = 1.24668 The DDB function is DDB(182000,50000,18,18,1.24668) D18 = 0.06926(182,000)(0.93074)17 = $3721
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The D18 value must be acceptable since d was calculated using estimated values. 16.23 (a) d = 1.5/12 = 0.125 D1 = 0.125(175,000)(0.875)11 = $21,875 BV1 = 175,000(0.875)1 = $153,125 D12 = 0.125(175,000)(0.875)121 = $5,035 BV12 = 175,000(0.875)12 = $35,248 (b) (c) The 150% DB salvage value of $35,248 is larger than S = $32,000. = DDB(175000,32000,12,t,1.5) for t = 1, 2, , 12

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16.24 One version of a MACRS depreciation template is shown. Cut and paste the appropriate rate series into column B, enter the basis in cell C1 and the results are presented.

16.25 Personal property: manufacturing equipment, construction equipment, company car Real property: warehouse building; rental house (not land of any kind)

16.26 B = $500,000 S = $100,000 n = 10 years


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SL: DDB: 150% DB: MACRS:

d = 1/n = 1/10 d = 2/10 = 0.20 d = 1.5/10 = 0.15 d = 0.1

D1 = (B-S)/n = (500,000 100,000)/10 = $40,000 D1 = dB = 0.20(500,000) = $100,000 D1 = dB = 0.15(500,000) = $75,000 D1 = 0.1(500,000) = $50,000

The first-year tax depreciation amounts vary considerably from $40,000 to $100,000. 16.27 (a) SL Depreciation each year = (30,000 2000)/7 = $4000 Straight line method Year 0 1 2 3 4 5 6 7 8 Depr $4,000 4,000 4,000 4,000 4,000 4,000 4,000 0 Book value $30,000 26,000 22,000 18,000 14,000 10,000 6,000 2,000 2,000 d rate 0.1429 0.2449 0.1749 0.1249 0.0893 0.0892 0.0893 0.0446 MACRS method Depr $4,287 7,347 5,247 3,747 2,679 2,676 2,679 1,338 Book value_ $30,000 25,713 18,366 13,119 9,372 6,693 4,017 1,338 0

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(b) Calculate the BV values and plot using the xy scatter chart.

16.28 (a) and (b) For MACRS use Table 16.2 rates for n = 5. For DDB, with d = 0.2857, stop depreciating at S = $10,000. (a) MACRS Year d rate 0.20 0.32 3 0.1152 0.1152 0.0576 $10,000 16,000 0.192 5,760 5,760 2,880 (b) Depr BV Depr

DDB________ BV__ 0 1 2 18,222 4 5 6 7

$50,000 $50,000 40,000 $14,285 35,715 24,000 10,204 25,511 9,600 14,400 7,288 8,640 2,880 0 0 5,206 3,016* 13,016 10,000 10,000 10,000

*D5 = 0.2857(13,016) = $3,719 is too large since BV < $10,000


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MACRS depreciates to BV = 0 while DDB stops at S = $10,000. (c) Plot the depreciation and BV columns on xy scatter charts.

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16.29 For classical SL, n = 5 and D t = 450,000/5 = $90,000 BV3 = 450,000 3(90,000) = $180,000 For MACRS, after 3 years for n = 5 sum the rates in Table 16.2. Dt = 450,000(0.712) = $320,400 BV3 = $450,000-320,400 = $129,600 The difference is $50,400, which has not been removed by classical SL depreciation. 16.30 Use n = 39 with d = 1/39 = 0.02564 in all 38 years except years 1 and 40 as specified by MACRS. Year d rate Depreciation ___ 1 0.01391 $25,038 2-39 0.02564 46,152 40 0.01177 21,186 16.31 (a) For MACRS, use n = 5 and the Table 16.2 rates with B = $100,000. For SL, use n = 10 with d = 0.05 in years 1 and 11 and d = 0.1 in all others Year 0 1 2 3 4 5 6 7 8 9 10 5000 11 0 Plot the two BV columns on one graph manually and by Excel chart. MACRS: sum d values for 3 years: 0.20 + 0.32 + 0.192 = 0.712 (71.2%) SL: sum the d values for 3 years: 0.05 + 0.1 + 0.1 = 0.25 (25%) SL depreciates much slower early in the recovery period. 16.32 ADS recovery rates are d = = 0.25 except for years 1 and 5, which are 50% of this. Year 1 2 SL 33.3 33.3 d values (%)______________________ MACRS ADS MACRS 33.33 12.5 44.45 25.0 (b) ------------0 0.05 5000 _______MACRS d Depr BV $100,000 0.2000 $20,000 80,000 0.3200 32,000 48,000 0.1920 19,200 28,800 0.1152 11,520 17,280 0.1152 11,520 5760 0.0576 5760 0 ------------0 ------------0 ------------0 ------------d 0.05 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0 SL _____________ Depr BV ____ $100,000 $ 5,000 95,000 10,000 85,000 10,000 75,000 10,000 65,000 10,000 55,000 10,000 45,000 10,000 35,000 10,000 25,000 10,000 15,000 0.10 10,000

3 4 5

33.3 0

14.81 7.41

25.0 25.0 12.5

16.33 There is a larger depreciation allowance that is tax deductible, so more revenue is retained as net profit after taxes. 16.34 (a) Use Equation [16.15] for cost depletion factor. pt = 1,100,000/350,000 = $3.143 per ounce Cost depletion, 3 years = 3.143(175,000) = $550,025 (b) Remaining investment = 1,100,000 550,025 = $549,975 New pt = 549,975/100,000 = $5.50 per ounce (c) Cost depletion: $Depl = 35,000(5.50) = $192,500

Percentage depletion: %Depl = 15% of gross income = 0.15(35,000)(5.50) = $28,875 From Equation [16.17], %Depl < $Depl; depletion for the year is $Depl = $192,500

16.35 Percentage depletion for copper is 15% of gross income, not to exceed 50% of taxable income. Year 1 2 3 Gross* income $3,200,000 7,020,000 2,990,000 % Depl @ 15% $480,000 1,053,000 448,500 50% of TI $750,000 1,000,000 500,000 Allowed depletion $480,000 1,000,000 448,500

*GI = (tons)($/pound)(2000 pounds/ton) 16.36 (a) pt = $3.2/2.5 million = $1.28 per ton Percentage depletion is 5% of gross income each year Tonnage for cost depletion 60,000 50,000 58,000 60,000 65,000 Per-ton gross income $30 25 35 35 40 Gross income for percentage depletion___ $ 1,800,000 1,250,000 2,030,000 2,100,000 2,600,000

Year 1 2 3 4 5

16.36 (cont) Year 1 2 3 4 5 (b) $Depl, $1.28 x tonnage per year $76,800 64,000 74,240 76,800 83,200 %Depl, 5% of GI $90,000 62,500 101,500 105,000 130,000 Selected %Depl $Depl %Depl %Depl %Depl

Total depletion is $490,500 % written off = 490,500/3.2 million = 15.33%

(c) Set up the spreadsheet with all needed data.

(d) The undepleted investment after 3 years: 3.2 million (90,000 + 64,000 + 101,500) = $2,944,500 New cost depletion factor is: pt = $2.9445 million/1.5 million tons = $1.963 per ton Cost depletion for years 4 and 5: year 4: 60,000(1.963) = $117,780 (> %Depl) year 5: 65,000(1.983) = $127,595 (< %Depl) Percentage depletion amounts are the same. Conclusion: Select $Depl for year 4 and %Depl in year 5. % written off = $503,280/3.2 million = 15.73%

FE Review Solutions 16.37 D = 20,000 2000 5 Answer is (a) = $3600 per year

16.38 From table, depreciation factor is 17.49%. D = 35,000(0.1749) = $6122 Answer is (d) 16.39 D = 50,000 10,000 = $8000 per year 5 BV3 = 50,000 3(8,000) = $26,000 Answer is (b) 16.40 The MACRS depreciation rates are 0.2 and 0.32. D1 = 50,000(0.20) = $10,000 D2 = 50,000(0.32) = $16,000 BV2 = 50,000 10,000 16,000 = $24,000 Answer is (c) 16.41 By the straight line method, book value at end of assets life MUST equal salvage value ($10,000 in this case). Answer is (c) 16.42 Total depreciation = first cost BV after 3 years = 50,000 21,850 = $28,150 Answer is (d) 16.43 Straight line rate is always used as the reference. Answer is (a)

Chapter 16 Appendix
Solutions to Problems 16A.1 The depreciation rate is from Eq. [16A.4] using SUM = 36. t 1 2 3 4 5 6 7 8 dt 8/36 7/36 6/36 5/36 4/36 3/36 2/36 1/36 D t, euro 2,222.22 1,944.44 1,666.67 1,388.89 1,111.11 833.33 555.56 277.78 BVt, euro 9777.78 7833.33 6166.67 4777.78 3666.67 2833.33 2277.78 2000.00

BV1 = 12,000 [ 1(8 0.5 + 0.5) ] (12,000 2000) = 9777.78 euro 36 BV2 = 12,000 [ 2(8 1 + 0.5) ] (10,000) = 7833.33 euro 36 16A.2 (a) Use B = $150,000; n = 10; S = $15,000 and SUM = 55. D2 = 10 2 + 1 (150,000 15,000) = $22,091 55 BV2 = 150,000 [ 2(10 1 + 0.5) ] (150,000 15,000) = $103,364 55 D7 = 10 7 + 1 (150,000 15,000) = $9818 55 BV7 = 150,000 [ 7(10 3.5 + 0.5) ] (150,000 15,000) = $29,727 55

(b)

16A.3 B = $12,000; n = 6 and S = 0.15(12,000) = $1,800 (a) Use Equation. [16A.3] and S = 21. BV3 = 12,000 [ 3(6 1.5 + 0.5) ](12,000 1800) = $4714 21 (b) By Eq. [16A.4] and t = 4: d4 = 6 4 + 1 = 3/21 = 1/7 21 D4 = d4(B S) = (3/21)(12,000 1800) = $1457

16A.4 B = $45,000

n = 5 S = $3000

i = 18%

Compute the Dt for each method and select the larger value to maximize PWD. For DDB, d = 2/5 = 0.4. By Equation [16A.6], BV5 = 45,000(1 0.4)5 = 3499 > 3000 Switching is advisable. Remember to consider S = $3000 in Equation [16A.8].

t 0 1 2 3 4 5

DDB Method Eq. [16A.7] BV $45,000 $18,000 27,000 10,800 16,200 6,480 9,720 3,888 5,832 2,333 3,499*

Switching to SL method Eq. [16A.8] $8,400 6,000 4,400 3,360 2,832

Larger Depr ________ $18,000 (DDB) 10,800 (DDB) 6,480 (DDB) 3,888 (DDB) 2,832 (SL)

*BV5 will be $3000 exactly when SL depreciation of $2832 is applied in year 5. BV5 = 5832 2832 = $3000 The switch to SL occurs in year 5 and the PW of depreciation is: PWD = 18,000(P/F,18%,1) +. . . + 2,832(P/F,18%,5) = $30,198

16A.5 Develop a spreadsheet for the DDB-to-SL switch using the VDB function (column B) and MACRS values plus the PWD for both methods.

Were switching allowed in the USA, it would give only a slightly higher PWD = $30,198 compared to the value for MACRS of PWD = $29,128.

16A.6 175% DB: d = 1.75 = 0.175 10 BVt = 110,000(0.825)t SL:

for t = 1 to 5

Dt = BV5 10,000 = (42,040 10,000)/5 = $6408 5 BV = BV5 t(6408)

for t = 6 to 10

PWD = $64,210 from Column D using the NPV function.

=NPV(12%,B5:B9)+NPV(12%,C5:C14)

16A.7 (a)

Use Equation [16A.6] for DDB with d = 2/25 = 0.08. BV25 = 155,000(1 0.08)25 = $19,276.46 < $50,000 No, the switch should not be made.

(b)

155,000(1-d)25 > 50,000 1 d > [ 50,000/155,000]1/25 1 - d > (0.3226)0.04 = 0.95575 d < 1 - 0.95575 = 0.04425 If d < 0.04425 the switch is advantageous. This is approximately 50% of the current DDB rate of 0.08. The SL rate would be d = 1/25 = 0.04.

16A.8 Verify that the rates are the following with d = 0.40: t dt 1 0.20 2 0.32 3 0.192 4 0.1152 5 0.1152 6 0.0576

d1: d2:

dDB, 1 = 0.5d = 0.20 By Eq. [16A.14] for DDB: dDB, 2 = 0.4(1 0.2) = 0.32 By Eq. [16A.15] for SL: dSL, 2 = 0.8/4.5 = 0.178 (Selected)

d3:

For DDB dDB, 3 = 0.4(1 0.2 0.32) = 0.192 For SL dSL, 2 = 0.48/3.5=0.137 (Selected)

d4:

dDB, 4 = 0.4(1 0.2 0.32 0.192) = 0.1152 dSL, 4 = 0.288/2.5 = 0.1152

(Select either)

Switch to SL occurs in year 4. d5: d6: Use the SL rate n = 5. dSL, 5 = 0.1728/1.5 = 0.1152 dSL, 6 is the remainder or 1/2 the d5 rate. 5 dSL, 6 = 1 dt = 1 (0.2 + 0.32 + 0.192 + 0.1152 + 0.1152) t=1 =0.0576 16A.9 B = $30,000 n = 5 years d = 0.40

Find BV3 using dt rates derived from Equations [16A.10] through [16A.12]. t = 1: d1 = 1/2(0.4) = 0.2 D1 = 30,000(0.2) = $6000 BV1=$24,000 t = 2: For DDB depreciation, use Eq. [16A.11] d = 0.4 DDB = 0.4(24,000) = $9600

BV2 = 24,000 9600 = $14,400 For SL, if switch is better, in year 2, by Eq. [16A.12]. DSL = 24,000 = $5333 52+1.5 Select DDB; it is larger. t = 3: For DDB, apply Eq. [16A.11] again. DDB = 14,400(0.4) = $5760 BV3 = 14,400 5760 = $8640 For SL, Eq. [16A.12] DS = 14,400 = $4114 53+1.5 Select DDB. Conclusion: When sold for $5000, BV3 = $8640. Therefore, there is a loss of $3640 relative to the MACRS book value.

NOTE: If Table 16.2 rates are used, cumulative depreciation in % for 3 years is: 20 + 32 + 19.2 = 71.2% 30,000(0.712) = $21,360 BV3 = 30,000 21,360 = $8640 16A.10 Determine MACRS depreciation for n = 7 using Equations [16A.10] through [16A.12]. and apply them to B = $50,000. (S) indicates the selected method and amount. DDB t = 1: d = 1/7 = 0.143 DDB = $7150 (S) BV1 = $42,850 t = 2: d = 2/7 = 0.286 DDB = $12,255 (S) BV2 = $30,595 t = 3: d = 0.286 DDB = $8750 (S) SL___________ DSL = 0.5(1/7)(50,000) = $3571 DSL = 42,850 = $6592 72+1.5 DSL = 30,595 = $5563 73+1.5

BV3 = $21,845 t = 4: d = 0.286 DDB =$6248 BV4 =15,597 (S) DSL = 21,845 = $4854 74+1.5 DSL = 15,597 = $4456 75+1.5 DSL = 11,136 = $4454(S) 76+1.5 BV6 = $6682 DSL = 6682 = $4454 77+1.5 BV7 = $2228 DSL = $2228 BV8 = 0

t = 5: d = 0.286 DDB = $4461 (S) BV5 = $11,136 t = 6: d = 0.286 DDB = $3185 (Use SL hereafter) t = 7:

t = 8:

The depreciation amounts sum to $50,000. Year 1 2 3 4 Depr $ 7150 12,255 8750 6248 Year 5 6 7 8 Depr__ $4461 4454 4454 2228

16A.11 (a) The SL rates with the half-year convention for n = 3 are: Year 1 2 3 4 (b) t 1 MACRS $26,664 SL Alternative $13,360 2 35,560 26,640 3 11,848 26,640 4 5928 13,360 PW D $61,253 $56,915 d rate 0.167 0.333 0.333 0.167 Formula 1/2n 1/n 1/n 1/2n

The MACRS PWD is larger by $4338.